The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest

(SARFAESI) Act, 2002 is a legislation that helps financial institutions to ensure asset quality in
multiple ways. This means that the Act was framed to address the problem of NPAs (Non-
Performing Assets) or bad assets through different processes and mechanisms.

The SARFAESI Act gives detailed provisions for the formation and activities of Asset
Securitization Companies (SCs) and Reconstruction Companies (RCs). Scope of their activities,
capital requirements, funding etc. are given by the Act. RBI is the regulator for these institutions.

As a legal mechanism to insulate assets, the Act addresses the interests of secured creditors (like
banks). Several provisions of the Act give directives and powers to various institutions to
manage the bad asset problem. Following are the main objectives of the SARFAESI Act.

 The Act provides the legal framework for securitization activities in India
 It gives the procedures for the transfer of NPAs to asset reconstruction companies for the
reconstruction of the assets.
 The Act enforces the security interest without Court’s intervention
 The Act give powers to banks and financial institutions to take over the immovable
property that is hypothecated or charged to enforce the recovery of debt.

Major feature of SARFAESI is that it promotes the setting up of asset reconstruction (RCs) and
asset securitization companies (SCs) to deal with NPAs accumulated with the banks and
financial institutions. The Act provides three methods for recovery of NPAs, viz:

(i) Securitization;
(ii) Asset Reconstruction; and
(iii) Enforcement of Security without the intervention of the Court.

The Act, thus brings three important tools/powers into asset management of financial banks and
institutions – securitization of assets, reconstruction of assets and powers for enforcement of
security interests (means asset security interests). To understand the SARFAESI Act, we should
know the meaning of these terms as well.

What is Securitization?
Securitization is the process of pooling and repackaging of financial assets (like loans given) into
marketable securities that can be sold to investors.

In the context of bad asset management, securitization is the process of conversion of existing
less liquid assets (loans) into marketable securities. The securitization company takes custody of
the underlying mortgaged assets of the loan taker. It can initiate the following steps:
i. Acquisition of financial assets from any originator (bank), and
ii. Raising of funds from qualified institutional buyers by issue of security receipts (for
raising money) for acquiring the financial assets or
iii. Raising of funds in any prescribed manner, and
iv. acquisition of financial asset may be coupled with taking custody of the mortgaged
land, building etc.

What is asset reconstruction?

Asset reconstruction is the activity of converting a bad or non-performing asset into performing
asset. The process of asset reconstruction involves several steps including purchasing of bad
asset by a dedicated asset reconstruction company (ARC) including the underlying hypothecated
asset, financing of the bad asset conversion into good asset using bonds, debentures, securities
and cash, realization of returns from the hypothecated assets etc.

Reconstruction, is to be done with the RBI regulations and the SARFAESI Act gives the
following components for reconstruction of assets: –
a. taking over or changing the management of the business of the borrower,
b. the sale or lease of a part or whole of the business of the borrower;
c. rescheduling of payment of debts payable by the borrower;
d. enforcement of security interest in accordance with the provisions of this Act;
e. settlement of dues payable by the borrower;
 f. taking possession of secured assets in accordance with the provisions of this Act.

What is mean by ‘enforcement of security interests’?

The Act empowers the lender (banker), when the borrower defaults, to issue notice to the
defaulting borrower and guarantor, calling to repay the debt within 60 days from the date of the
notice. If the borrower fails to comply with the notice, the bank or the financial institution may
enforce security interests (means interest of the bank/creditor) by following the provisions of the
Act:
a. Take possession of the security;
b. Sale or lease or assign the right over the security;
c. Appoint Manager to manage the security;
d. Ask any debtors of the borrower to pay any sum due to the borrower.

If there are more than one secured creditors, the decision about the enforcement of SARFEASI
provisions will be applicable only if 75% of them are agreeing.